One of the greatest tools in self-storage investing – the most powerful of them all – is leverage. The simple existence of sensible leverage on a storage property can spike the return up significantly as well as to allow the buyer the ability to own something far beyond their typical budget. So how does leverage work as a beneficial tool to make money with a storage facility?
The ability to buy something much larger than your cash will afford
If you have $200,000 to invest, you can buy $200,000 or stocks or bonds. Or you can buy a business for $200,000. But with a self-storage facility – assuming 80% loan-to-value – you can buy a $1 million property. That’s the magic of leverage; it allows you to buy assets at a multiple of the cash on hand. In this manner, if your stock goes up 20%, you’d make $40,000 on that $200,000 stock purchase. But on that leveraged self-storage facility you’d make $200,000 [20% times $1 million]. That’s a pretty big difference that is created with bank debt.
The ability to spike rates of return with sensible leverage
Going back to the example of $200,000 of bonds, let’s assume those bonds have a yield of 7%. In that case you’d make $14,000 per year. But if you bought a storage facility with the same yield of 7% -- but financed it with 80% debt at an interest rate of 5% -- then here’s where you’d end up:
Net income on the storage facility of $70,000 per year
$1,000,000 valuation at a 7% cap rate
$200,000 down payment
$800,000 bank loan at 5% equals interest of $40,000
Net income after interest on the loan equals $30,000
Return on $200,000 down payment equals 15%
The bottom line is that sensible leverage on the storage facility more than doubled your rate of return on your money.
The ability to take risks with less “skin in the game” with non-recourse debt
There are two types of debt on storage facilities: 1) recourse and 2) non-recourse. While recourse debt means that the bank can come after you if you fail to pay back the loan, non-recourse means that the bank’s only avenue if you default is to take the property back. This means that non-recourse debt also allows you to lower your business risk. If you bet on a storage facility and bet wrong, non-recourse debt will let you off the hook. If our model of a $1,000,000 self-storage went bankrupt, you would only lose your $200,000 down payment. This is another important aspect of lending significance and desirability.
Conclusion
Leverage is an important tool for self-storage buyers. It has unique benefits that are extremely powerful, and is the reason that real estate has been the #1 source of wealth-building in the U.S. over the past 200 years.